2015 FRM practice exam

2015 FRM Practice Exam 2015 Financial Risk Manager (FRM®) Practice Exam TABLE OF CONTENTS Introduction Reference Table Special instructions 2015 FRM Part I Practice Exam Candidate Answer Sheet 2015 FRM Part I Practice Exam Questions 2015 FRM Part I Practice Exam Answer Sheet/Answers 19 2015 FRM Part I Practice Exam Explanations 21 2015 FRM Part II Practice Exam Candidate Answer Sheet 45 2015 FRM Part II Practice Exam Questions 47 2015 FRM Part II Practice Exam Answer Sheet/Answers 57 2015 FRM Part II Practice Exam Explanations 59 © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc i 2015 Financial Risk Manager (FRM®) Practice Exam INTRODUCTION Core readings were selected by the FRM Committee to assist candidates in their review of the subjects covered The FRM Exam is a practice-oriented examination Its questions by the Exam Questions for the FRM Exam are derived are derived from a combination of theory, as set forth in the from the “core” readings It is strongly suggested that core readings, and “real-world” work experience Candidates candidates review these readings in depth prior to sitting are expected to understand risk management concepts and for the Exam approaches and how they would apply to a risk manager’s day-to-day activities The FRM Exam is also a comprehensive examination, testing a risk professional on a number of risk management Suggested Use of Practice Exams To maximize the effectiveness of the Practice Exams, candidates are encouraged to follow these recommendations: concepts and approaches It is very rare that a risk manager will be faced with an issue that can immediately be slotted Plan a date and time to take each Practice Exam into one category In the real world, a risk manager must be Set dates appropriately to give sufficient study/ able to identify any number of risk-related issues and be review time for the Practice Exam prior to the able to deal with them effectively actual Exam The 2015 FRM Practice Exams I and II have been developed to aid candidates in their preparation for the FRM Exam in Simulate the test environment as closely as possible May and November 2015 These Practice Exams are based • Take each Practice Exam in a quiet place on a sample of questions from the 2011 through 2014 FRM • Have only the practice exam, candidate answer sheet, calculator, and writing instruments (pencils, Exams and are suggestive of the questions that will be in erasers) available the 2015 FRM Examination The 2015 FRM Practice Exam for Part I contains 25 • cell phones and study material multiple-choice questions and the 2015 FRM Practice Exam for Part II contains 20 multiple-choice questions Note that Minimize possible distractions from other people, • Allocate 60 minutes for the Practice Exam and the 2015 FRM Exam Part I will contain 100 multiple-choice set an alarm to alert you when 60 minutes have questions and the 2015 FRM Exam Part II will contain passed Complete the exam but note the questions 80 multiple-choice questions The Practice Exams were answered after the 60 minute mark designed to be shorter to allow candidates to calibrate • Follow the FRM calculator policy You may only use a Texas Instruments BA II Plus (including the BA II their preparedness without being overwhelming Plus Professional), Hewlett Packard 12C (including The 2015 FRM Practice Exams not necessarily cover all topics to be tested in the 2015 FRM Exam as the material the HP 12C Platinum and the Anniversary Edition), covered in the 2015 Study Guide may be different from Hewlett Packard 10B II, Hewlett Packard 10B II+ or that covered by the 2011 through 2014 Study Guides The Hewlett Packard 20B calculator questions selected for inclusion in the Practice Exams were chosen to be broadly reflective of the material assigned for 2015 as well as to represent the style of question that the After completing the Practice Exam, • Calculate your score by comparing your answer FRM Committee considers appropriate based on assigned sheet with the Practice Exam answer key Only material include questions completed in the first 60 minutes • Use the Practice Exam Answers and Explanations For a complete list of current topics, core readings, and key learning to better understand correct and incorrect objectives candidates should refer to the 2015 FRM Exam Study Guide answers and to identify topics that require addi- and Program Manual tional review Consult referenced core readings to prepare for Exam © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 2015 Financial Risk Manager (FRM®) Practice Exam Reference Table: Let Z be a standard normal random variable © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 2015 Financial Risk Manager (FRM®) Practice Exam Special Instructions and Definitions Unless otherwise indicated, interest rates are assumed to be continuously compounded Unless otherwise indicated, option contracts are assumed to be on one unit of the underlying asset VaR = value-at-risk ES = expected shortfall GARCH = generalized auto-regressive conditional heteroskedasticity CAPM = capital asset pricing model LIBOR = London interbank offer rate EWMA = exponentially weighted moving average CDS = credit default swap (s) 10 MBS = mortgage-backed security (securities) 11 CEO/CFO/CRO = Senior management positions: Chief Executive Officer, Chief Financial Officer, and Chief Risk Officer, respectively 12 The following acronyms are used for selected currencies: Acronym Currency ARS Argentine peso AUD Australian dollar BRL Brazilian real CAD Canadian dollar CHF Swiss franc EUR euro GBP British pound sterling HKD Hong Kong dollar INR Indian rupee JPY Japanese yen MXN Mexican peso SGD Singapore dollar USD US dollar © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 2015 ® FRM Practice Exam Part I Answer Sheet 2015 Financial Risk Manager (FRM®) Practice Exam a b c d a 16 17 18 19 20 21 22 23 24 10 25 b c d ✓ ✘ 11 12 Correct way to complete 13 14 Wrong way to complete 15 © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 2015 ® FRM Practice Exam Part I Questions 2015 Financial Risk Manager (FRM®) Practice Exam Rarecom is a specialist company that only trades derivatives on rare commodities Rarecom and a handful of other firms, all of whom have large notional outstanding contracts with Rarecom, dominate the market for such derivatives Rarecom management would like to mitigate its overall counterparty exposure, with the goal of reducing it to almost zero Which of the following methods, if implemented, could best achieve this goal? a b c d Ensuring that sufficient collateral is posted by counterparties Diversifying among counterparties Cross-product netting on a single counterparty basis Purchasing credit derivatives, such as credit default swaps Correct Answer: a Rationale: Counterparty exposure, in theory, can be almost completely neutralized as long as a sufficient amount of high quality collateral, such as cash or short-term investment grade government bonds, is held against it If the counterparty were to default, the holder of an open derivative contract with exposure to that counterparty would be allowed to receive the collateral Cross-product netting would only reduce the exposure to one of the counterparties, and purchasing credit derivatives would replace the counterparty risk from the individual counterparties with counterparty risk from the institution who wrote the CDS Section: Credit Risk Measurement and Management Reference: Jon Gregory, Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets, Chapter 3, "Defining Counterparty Credit Risk." Learning Objective: Identify and describe the different ways institutions can manage and mitigate counterparty risk 66 © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 2015 Financial Risk Manager (FRM®) Practice Exam Local Company, a frequent user of swaps, often enters into transactions with Global Bank, a major provider of swaps Recently, Global Bank was downgraded from a rating of AA+ to a rating of A, while Local Company was downgraded from a rating of A to a rating of A- During this time, the credit spread for Global Bank has increased from 20 bps to 150 bps, while the credit spread for Local Company has increased from 130 bps to 170 bps Which of the following is the most likely action that the counterparties will request on their credit value adjustment (CVA)? a b c d The credit qualities of the counterparties have migrated, but not significantly enough to justify amending existing CVA arrangements Global Bank requests an increase in the CVA charge it receives Local Company requests a reduction in the CVA charge it pays CVA is no longer a relevant factor, and the counterparties should migrate to using other mitigants of counterparty risk Correct Answer: c Rationale: Because Local Bank has a lower credit rating than Global Bank, it would typically pay a CVA charge to Global Bank which would be a function of the relative credit spread between the two banks After the downgrades of both Global Bank and Local Bank, the credit spread between the two banks narrowed from 110 bps initially to only 20 bps after the downgrades Therefore, with the spread much lower between the two banks, Local Bank would be in a position to request a reduction in the CVA charge that it pays Section: Credit Risk Measurement and Management Reference: Jon Gregory, Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets, Chapter 12, "Credit Value Adjustment.” Learning Objective: Explain the motivation for and the challenges of pricing counterparty risk © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 67 2015 Financial Risk Manager (FRM®) Practice Exam 10 An analyst estimates that the hazard rate for a company is 0.1 per year The probability of survival in the first year followed by a default in the second year is closest to: a b c d 8.61% 9.00% 9.52% 19.03% Correct Answer: a Rationale: The probability that the firm defaults in the second year is conditional on its surviving the first year Using λ to represent the given hazard rate, we can calculate the cumulative probability of default in the first year using the formula - exp(-λ), which equals 0.09516 Then, the cumulative probability that the firm defaults in the second year is equal to 1-exp(-2 * λ) or 0.18127, and the conditional one year default probability given that the firm survived the first year is the difference between the two year cumulative probability of default and the one year probability: 0.18127 - 0.09516 = 08611 Section: Credit Risk Measurement and Management Reference: Allan Malz, Financial Risk Management: Models, History, and Institutions (1st ed.), Chapter 7, “Spread Risk and Default Intensity Models,” pp 238-241 Learning Objective: Define the hazard rate and use it to define probability functions for default time and conditional default probabilities 68 © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 2015 Financial Risk Manager (FRM®) Practice Exam 11 At the beginning of the year, a firm bought an AA-rated corporate bond at USD 110 per USD 100 face value Using market data, the risk manager estimates the following year-end values for the bond based on interest rate simulations informed by the economics team: Rating Year-end Bond Value (USD per USD 100 face value) 112 109 105 101 92 83 73 50 AAA AA A BBB BB B CCC Default In addition, the risk manager estimates the 1-year transition probabilities on the AA-rated corporate bond: Rating AAA AA A BBB BB B CCC Default Probability of State 3.00% 85.00% 7.00% 4.00% 0.35% 0.25% 0.15% 0.25% What is the 1-year 95% credit VaR per USD 100 of face value closest to? a b c d USD USD USD USD 18 30 36 Correct Answer: a Rationale: The 95% credit VaR corresponds to the unexpected loss at the 95th percentile minus the expected loss, or the expected future value at the 95% loss percentile minus the current value Using the probabilities in the given ratings transition matrix, the 95% percentile corresponds to a downgrade to BBB, at which the value of the bond would be estimated at 101 Since cash flows for the bond are not provided, we cannot derive the precise expected and unexpected losses, but the credit VaR (the difference) is easily derived by subtracting the estimated value given a BBB rating from the current value 95% credit VaR = 110 – 101 = Section: Credit Risk Measurement and Management Reference: Allan Malz, Financial Risk Management: Models, History, and Institutions, 1st Edition, Chapter 6, “Credit and Counterparty Risk.” Learning Objective: Define and calculate Credit VaR © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 69 2015 Financial Risk Manager (FRM®) Practice Exam 12 A risk manager is advising the trading desk about entering into a digital credit default swap as a way to obtain credit protection Which cash flow and delivery requirement will the desk most likely experience in the event of a default of the underlying reference asset? a b c d Receive Receive Receive Receive the pre-agreed cash payment; deliver nothing [(Par Value) - (Market Value of Reference Asset)]; deliver the reference asset [(Par Value) - (Market Value of Reference Asset)]; deliver nothing the pre-agreed cash payment; deliver the reference asset Correct Answer: a Rationale: A digital CDS will pay off a pre-determined fixed amount in the event of a default Digital CDS are often used against highly illiquid reference assets that would be difficult to price Section: Credit Risk Measurement and Management Reference: Christopher Culp (2006), Structured Finance and Insurance: The Art of Managing Capital and Risk, 1st Edition, Chapter 12, “Credit Derivatives and Credit Linked Notes,” pp 252-254 Learning Objective: Describe the mechanics and attributes of a single named credit default swap (CDS) 13 Computing VaR on a portfolio containing a very large number of positions can be simplified by mapping these positions to a smaller number of elementary risk factors Which of the following mappings would be adequate? a b c d USD/EUR forward contracts are mapped on the USD/JPY spot exchange rate Each position in a corporate bond portfolio is mapped on the bond with the closest maturity among a set of government bonds Government bonds paying regular coupons are mapped on zero-coupon government bonds A position in the stock market index is mapped on a position in a stock within that index Correct Answer: c Rationale: Mapping government bonds paying regular coupons onto zero coupon government bonds is an adequate process, because both categories of bonds are government issued and therefore have a very similar sensitivity to risk factors However, this is not a perfect mapping since the sensitivity of both classes of bonds to specific risk factors (i.e changes in interest rates) may differ Section: Market Risk Measurement and Management Reference: Philippe Jorion, Value-at-Risk: The New Benchmark for Managing Financial Risk, 3rd Edition, Chapter 11, “VaR Mapping.” Learning Objective: Explain the principles underlying VaR mapping, and describe the mapping process 70 © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 2015 Financial Risk Manager (FRM®) Practice Exam 14 The dependence structure between the returns of financial assets plays an important role in risk measurement For liquid markets, which of the following statements is incorrect? a b c d Correlation is a valid measure of dependence between random variables for only certain types of return distributions Even if the return distributions of two assets have a correlation of zero, the returns of these assets are not necessarily independent Copulas make it possible to model marginal distributions and the dependence structure separately With short time horizons (3 months or less), correlation estimates are typically very stable Correct Answer: d Rationale: Correlation estimates tend to be very volatile when short term time horizons are considered Section: Market Risk Measurement and Management Reference: Kevin Dowd (2005), Measuring Market Risk, 2nd Edition, Chapter 5, Appendix: “Modeling Dependence: Correlations and Copulas.” Learning Objective: Explain the drawbacks of using correlation to measure dependence Describe how copulas provide an alternative measure of dependence Reference: Gunter Meissner, Correlation Risk Modeling and Management, Chapter 1, “Some Correlation Basics: Properties, Motivation, Terminology.” Learning Objective: Describe financial correlation risk and the areas in which it appears in finance © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 71 2015 Financial Risk Manager (FRM®) Practice Exam A risk manager is in the process of valuing several European option positions on a non-dividend-paying stock XYZ that is currently priced at GBP 30 The implied volatility skew, estimated using the Black-Scholes-Merton model and the current prices of actively traded European-style options on stock XYZ at various strike prices, is shown below: Implied Volatility 15 Strike Price (GBP) Assuming that the implied volatility at GBP 30 is used to conduct the valuation, which of the following long positions will be undervalued? a b c d An An An An out-of-the-money call in-the-money call at-the-money put in-the-money put Correct Answer: b Rationale: An in-the-money call has a strike price below 30 Therefore, using the chart above, its implied volatility is greater than the at-the-money volatility, so using the at-the-money implied volatility would result in pricing an in-the-money call option lower than its fair price Section: Market Risk Measurement and Management Reference: John Hull, Options, Futures, and Other Derivatives, 9th Edition, Chapter 20, “Volatility Smiles.” Learning Objective: Compare the shape of the volatility smile (or skew) to the shape of the implied distribution of the underlying asset price and to the pricing of options on the underlying asset 72 © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 2015 Financial Risk Manager (FRM®) Practice Exam 16 A risk manager is pricing a 10-year call option on 10-year Treasuries using a successfully tested pricing model Current interest rate volatility is high and the risk manager is concerned about the effect this may have on short-term rates when pricing the option Which of the following actions would best address the potential for negative short-term interest rates to arise in the model? a b c d The risk manager uses a normal distribution of interest rates When short-term rates are negative, the risk manager adjusts the risk-neutral probabilities When short-term rates are negative, the risk manager increases the volatility When short-term rates are negative, the risk manager sets the rate to zero Correct Answer: d Rationale: Negative short-term interest rates can arise in models for which the terminal distribution of interest rates follows a normal distribution The existence of negative interest rates does not make much economic sense since market participants would generally not lend cash at negative interest rates when they can hold cash and earn a zero return One method that can be used to address the potential for negative interest rates when constructing interest rate trees is to set all negative interest rates to zero This localizes the change in assumptions to points in the distribution corresponding to negative interest rates and preserves the original rate tree for all other observations In comparison, adjusting the risk neutral probabilities would alter the dynamics across the entire range of interest rates and therefore not be an optimal approach When a model displays the potential for negative short-term interest rates, it can still be a desirable model to use in certain situations, especially in cases where the valuation depends more on the average path of the interest rate, such as in valuing coupon bonds Therefore, the potential for negative rates does not automatically rule out the use of the model Section: Market Risk Measurement and Management Reference: Bruce Tuckman, Fixed Income Securities, 3rd Edition, Chapter 9, “The Art of Term Structure Models: Drift.” Learning Objective: Describe methods for addressing the possibility of negative short-term rates in term structure models © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 73 2015 Financial Risk Manager (FRM®) Practice Exam 17 A large commercial bank is using VaR as its main risk measurement tool Expected shortfall (ES) is suggested as a better alternative to use during market turmoil What should be understood regarding VaR and ES before modifying current practices? a b c d Despite being more complicated to calculate, ES is easier to backtest than VaR Relative to VaR, ES leads to more required economic capital for the same confidence level While VaR ensures that the estimate of portfolio risk is less than or equal to the sum of the risks of that portfolio’s positions, ES does not Both VaR and ES account for the severity of losses beyond the confidence threshold Correct Answer: b Rationale: Expected shortfall is always greater than or equal to VaR for a given confidence level, since ES accounts for the severity of expected losses beyond a particular confidence level, while VaR measures the minimum expected loss at that confidence level Therefore, ES would lead to a higher level of required economic capital than VaR for the same confidence level In practice, however, regulators often correct for the difference between ES and VaR by lowering the required confidence level for banks using ES compared to those using VaR Section: Market Risk Measurement and Management Reference: Basel Committee on Banking Supervision, Messages from the Academic Literature on Risk Measurement for the Trading Book, Working Paper No 19, January 2011 Learning Objective: Compare VaR, expected shortfall, and other relevant risk measures 74 © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 2015 Financial Risk Manager (FRM®) Practice Exam 18 A risk management consultant is involved in evaluating the capital planning at a US-based bank holding company (BHC) with over USD 100 billion in total consolidated assets The evaluation includes looking at the stress testing program that is integral to the capital planning process In evaluating the BHC's design of stress scenarios, which of the following statements is correct? a b c d Although the BHC may feel it is losing some of its independence, limiting the scenarios to those developed by the Federal Reserve will ensure regulatory compliance To avoid introducing bias, if the BHC uses private sector third-party-defined scenarios, they should be implemented without alteration In order to properly assess both right-way and wrong-way risk in stress environments, assumptions should be included that specifically benefit the BHC When developing scenarios internally, it is acceptable to combine expert judgment with quantitative models rather than relying only on the models Correct Answer: d Rationale: According to the Board of Governors of the Federal Reserve, bank holding companies with superior scenario-design practices generally use a combination of internal models and expert judgment rather than relying solely on either practice by itself This allows the BHC to tailor scenarios or quantitative models to its own unique risk profile and vulnerabilities Therefore, combining expert judgment with quantitative models is clearly acceptable Section: Current Issues (Operational and Integrated Risk Management for 2015) Reading: “Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice,” Board of Governors of the Federal Reserve System, August 2013 Learning Objective: Describe practices which can result in a strong and effective capital adequacy process for a BHC in the following areas: Stress testing and stress scenario design © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 75 2015 Financial Risk Manager (FRM®) Practice Exam Question 19 refers to the following information: A profitable derivatives trading desk at a bank decides that its existing VaR model, which has been used broadly across the firm for several years, is too conservative The existing VaR model uses a historical simulation over a three-year look-back period, weighting each day equally A quantitative analyst in the group quickly develops a new VaR model, which uses the delta normal approach The new model uses volatilities and correlations estimated over the past four years using the Riskmetrics EWMA method For testing purposes, the new model is used in parallel with the existing model for four weeks to estimate the 1-day 95% VaR After four weeks, the new VaR model has no exceedances despite consistently estimating VaR to be considerably lower than the existing model's estimates The analyst argues that the lack of exceedances shows that the new model is unbiased and pressures the bank’s model evaluation team to agree Following an overnight examination of the new model by one junior analyst instead of the customary evaluation that takes several weeks and involves a senior member of the team, the model evaluation team agrees to accept the new model for use by the desk 19 Which of the following statements about the risk management implications of this replacement is correct? a b c d Delta-normal VaR is more appropriate than historical simulation VaR for assets with non-linear payoffs Changing the look-back period and weighing scheme from three years, equally weighted, to four years, exponentially weighted, will understate the risk in the portfolio The desk increased its exposure to model risk due to the potential for incorrect calibration and programming errors related to the new model A 95% VaR model that generates no exceedances in four weeks is necessarily conservative Correct Answer: c Rationale: Given the quick implementation of the new VaR model and the insufficient amount of testing that was done, the desk has increased its exposure to model risk due to the increased potential for incorrect calibration and programming errors This situation is similar to the JP Morgan London Whale case in 2012, where a new VaR model was very quickly introduced for its Synthetic Credit portfolio without appropriate time to test the model in response to increasing losses and multiple exceedances of the earlier VaR model limit in the portfolio Section: Operational and Integrated Risk Management Reference: Kevin Dowd, Measuring Market Risk, 2nd Edition, Chapter 16, “Model Risk.” Learning Objective: Define model risk; identify and describe sources of model risk Reference: Allan Malz, Financial Risk Management: Models, History, and Institutions, Chapter 11, "Assessing the Quality of Risk Measures," section 11.1 Learning Objective: Describe ways that errors can be introduced into models 76 © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 2015 Financial Risk Manager (FRM®) Practice Exam Section: Current Issues Reference: “JP Morgan Chase Whale Trades: A Case History of Derivatives Risks and Abuses—Executive Summary,” US Senate Subcommittee on Investigation, April 2013 Learning Objective: Summarize the deficiencies in risk management practices related to the SCP, including the VAR model change Section: Market Risk Measurement and Management Reference: Kevin Dowd, Measuring Market Risk, 2nd Edition, Chapter 3, “Estimating Market Risk Measures.” Learning Objective: Calculate VaR using a parametric estimation approach assuming that the return distribution is either normal or lognormal © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc 77 2015 Financial Risk Manager (FRM®) Practice Exam 20 The CFO at a bank is preparing a report to the board of directors on its compliance with Basel requirements The bank's average capital and total exposure for the most recent quarter is as follows: REGULATORY CAPITAL Total Common Equity Tier Capital Additional Tier Capital Prior to regulatory adjustments Regulatory adjustments USD MILLIONS 108 28 34 Total Tier Capital Tier Capital Prior to regulatory adjustments Regulatory adjustments 136 36 45 Total Capital Total Average Exposure 172 3678 Using the Basel III framework, which of the following is the best estimate of the bank’s current leverage ratio? a b c d 2.94% 3.70% 4.68% 5.08% Correct Answer: b Rationale: For Basel III purposes, the leverage ratio is Tier Capital / Total Exposure = 136 / 3,678= 3.70% Section: Operational and Integrated Risk Management Reference: “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems—Revised Version,” Basel Committee on Banking Supervision Publication, June 2011 Learning Objective: Describe changes to the regulatory capital framework, including changes to: Risk coverage, the use of stress tests, the treatment of counter-party risk with credit valuation adjustments, the use of external ratings, and the use of leverage ratios Reference: John Hull, Risk Management and Financial Institutions, 3rd Edition, Chapter 13, “Basel 2.5, Basel III, and Dodd-Frank.” Learning Objective: Describe and calculate ratios intended to improve the management of liquidity risk, including the required leverage ratio, the liquidity coverage ratio, and the net stable funding ratio 78 © 2015 Global Association of Risk Professionals All rights reserved It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc Creating a culture of risk awareness® Global Association of Risk Professionals 111 Town Square Place 14th Floor Jersey City, New Jersey 07310 U.S.A + 201.719.7210 2nd Floor Bengal Wing 9A Devonshire Square London, EC2M 4YN U.K + 44 (0) 20 7397 9630 www.garp.org About GARP | The Global Association of Risk Professionals (GARP) is a not-for-profit global membership organization dedicated to preparing professionals and organizations to make better informed risk decisions Membership represents over 150,000 Members and Affiliates from banks, investment management firms, government agencies, academic institutions, and corporations from more than 195 countries and territories GARP administers the Financial Risk Manager (FRM®) and the Energy Risk Professional (ERP®) Exams; certifications recognized by risk professionals worldwide GARP also helps advance the role of risk management via comprehensive professional education and training for professionals of all levels www.garp.org © 2014 Global Association of Risk Professionals All rights reserved 11-19-14 ... 2015 FRM Part I Practice Exam Candidate Answer Sheet 2015 FRM Part I Practice Exam Questions 2015 FRM Part I Practice Exam Answer... 19 2015 FRM Part I Practice Exam Explanations 21 2015 FRM Part II Practice Exam Candidate Answer Sheet 45 2015 FRM Part II Practice Exam. .. 47 2015 FRM Part II Practice Exam Answer Sheet/Answers 57 2015 FRM Part II Practice Exam Explanations 59 © 2015 Global Association